Coffee heat rising

Financial Freedom: Building the bankroll, part 2

We’ve seen that a key part to underwriting Bumhood is living below your means and using the resulting extra cash from income to build savings.

The corollary to this important principle is that your money needs to work for you. That means it has to earn money instead of you having to go to work to earn a paycheck.

How to make this happen? Invest. Your strategy should not be excessively conservative, because truly safe, FDIC-insured instruments such as high-interest savings accounts and CDs don’t return enough to keep up with inflation. Although clearly some cash should reside in your bank or credit union, where it will be insulated from a major market crash such as the one we recently saw, to grow your money you have to take some risk. This means investing something in the stock market or (yes!) in real estate.

Investment plans that work to support bumhood are long-haul arrangements.* Savings should be invested for the long term in reasonably stable instruments such as fairly staid mutual funds and left there, even when the market slides. Low-overhead mutual funds are an excellent choice, because the various costs involved in maintaining them do not bite significantly into your gains. Vanguard and Fidelity funds lead the pack here.

Some mutual funds buy stocks; others buy bonds; still others are balanced funds with a variety of investments. Read the prospectus for each fund that interests you, and be sure your choices don’t duplicate each other. Most advisers suggest that equities investments be allocated about 60 percent to stocks and about 40 percent to bonds, because as a general rule when stock values fall bond values rise. (This is a huge oversimplification, as I’m sure we’ll hear from readers. Study up on investment products. Several “For Dummies” books on the subject have good to excellent reviews, and regular reading of the Wall Street Journal and the New York Times business section can be instructive.)

Stocks and bonds are not the only places to grow savings. Some people have done well investing in rental real estate. This also is a long-term hold: expect to keep the property for 10 to 20 years before it turns a profit. As we’ve seen, for investors real estate presents no less risk than the stock market, and so you  need to be prepared to watch values go up and down. A quick perusal of Amazon’s offerings on real estate investment will clue you to the amount of snake oil out there: be extremely careful, and do not operate without a trusted adviser who can prove his (or her) expertise. As with the stock market, it’s important to do your homework and know what you’re doing before investing. If real estate interests you but the prospect of dealing with renters does not, consider a real estate investment trust (REIT) or an REIT mutual fund. Sometimes limited partnerships invest in commercial real estate, although this tool is probably not for everyone.

Because money sitting in the bank does nothing for you—it just sits there—it’s crucial to put your savings to work by investing in a diversified set of financial instruments, ranging from the relatively safe (CDs, the money market) to relatively risky. The degree of risk depends on your age (i.e., how many years you have left to make up any losses) and your personality. To make money work for you, you’ll need to take some risk with some part of your savings. But as you draw closer to your projected escape from the day job, it makes sense to pull back from riskier investments and shift funds to more conservative tools.

One way or another, at any age your savings should be working for you, and some part of it should be in stocks or instruments that earn similar returns. Over the years, my savings have returned about 8 to 9 percent, on average. Of course, that faltered when the Bush economy crashed. While the artificially pumped-up economy was hot, some months I would earn $8,000 on a $250,000 investment. Although all that went away when the market collapsed, returns are now back up in the 8 percent range.

Thus if I draw down the widely recommended 4 percent—more than I need to live on, as a matter of fact—savings will continue to grow even without my adding any  new cash.

And voilà! Full-blown financial freedom: Return on passive investments that meets or exceeds the amount you need to support yourself. The less you spend on your lifestyle, the more you can save, the more you can invest, and the sooner you can get off the day-job treadmill. Living below your means, faithful, regular saving, and wise investments can spring you free sooner than you think.

The Financial Freedom Series

An Overview
The Health Insurance Hurdle
Own Your Roof
Bankrolling Bumhood, Part 1


* I am not an investment adviser! I am just a writer sitting in front of a computer. No part of this information should be taken as investment advice. For advice on financial planning, consult a tax professional and a certified financial planner. Always read all prospectuses and related information before investing in any stock, bond, or mutual fund.

Return-of-Premium Insurance: Is it a good idea?

Over at Bargaineering, Jim recently discussed an relatively new insurance instrument called “Return of Premium Insurance.” This is a type of term life policy whose issuers promise to return your money after the policy expires.

In term insurance, you pay a specific monthly or annual premium so that the company will pay a benefit to your survivors should you die an untimely death. Unlike whole life insurance, which builds something like equity at a very low return, term does not pretend to be any sort of “investment.” It exists simply to protect a spouse or children from the loss of your income. A policy normally has a beginning and an end (typically ten to thirty years), after which it expires and, if you still need coverage, you have to buy a new one.

Return of premium (ROP) insurance offers to return your premiums after the policy expires. In other words, if you paid a total of, say, $15,000 over the term of the policy, at the end of the term you get the 15 grand back. Thus you appear to be getting something for nothing: the insurance coverage works like any term policy, but the amount you pay for it is returned to you if you outlive the policy.

This, we’re told, amounts to a kind of “investment,” and oh, joy, the money you get after 30 years is tax-free! (It’s really not income: it’s a refund.) This strategy supposedly has the advantage, in addition to providing “free” insurance coverage, of forcing you to save over a long period.

Let’s think about that.

ROP insurance costs significantly more than ordinary term insurance, and the costs are going up in 2010 because regulatory agencies now require companies to return a significant portion of your premiums should you cancel the policy before the end of the term. These policies can cost as much as 50% more than a plain term policy. If you can afford to pay that much for life insurance premiums, it stands to reason that you can afford to pay the cheaper amount for the same coverage with a term policy and put the difference away in a mutual fund.

A few insurance premium calculators that don’t make you a target for insurance salesmen reside on the Web. According to this one, an ordinary 30-year term policy for a 30-year-old man ranges from about $620 to $825 a year. A middling premium for term insurance, then, would be about $720. A similar calculator for ROP shows him paying $2,270.50 a year for a 30-year ROP policy.

The difference between $2,271 and $720 is $1,551 a year, or $129.25 a month.

At the end of his 30-year policy, our ROP buyer, who by then is 60 years old and contemplating retirement, gets $68,130 back. At that time, an average 4 percent inflation rate  has reduced the buying power of this amount to $21,005.75, in 2010 dollars.

What happens if our consumer buys the old-fashioned, plain-vanilla term policy and stashes the extra $129 a month in savings?

Let’s say he starts with nothing but invests the $129, faithfully, month after month, in a mutual fund returning a fairly typical 6 percent. In 30 years his fund is worth $129,582.44. The corrosive effect of inflation erodes the purchasing power of this amount, over 30 years, to $39,952.69. But even this pallid value is almost twice as much as he would have had were his premiums simply refunded to him.

Meanwhile, however, the insurance company is not hiding our consumer’s premiums under a mattress. It also is investing the money, but instead of a mere $129, the company has his entire ROP premium to invest: $189.25 a month. In 30 years at 6 percent, the policy earns $190,104.47 for the insurance company. After the company returns $68,130 to the customer, it sees a profit of $121,975.

That’s assuming the company stays in business for 30 years. We’ve seen what “too big to fail” means…who would have thought, just five years ago, that major banks would go down in the dust? An insurance company is just another financial institution, no more nor less vulnerable to the vagaries of future recessions than any other corporation. If the company folds before the 30-year policy expires, our consumer could very well lose all of his “investment,” since a bankrupt company is unlikely to honor a contract to return money it doesn’t have.

Pretty clearly ROP life insurance is a great idea…for the insurance companies!


Not bankrupt after all?

Despite the extreme market volatility and the various grim economic prognoses, so far my December investment statements come bearing news nowhere near as hideous as expected.

My big IRA went up by $2,000 last month. The Vanguard funds rose $5,000 in December. TIAA-CREF, in the past highly sensitive to recession, went up $40 over the past quarter. I haven’t received the quarterly report for the Fidelity funds in my 403(b), but the same guys who run my IRA and advised me how to invest in Vanguard also told me what to do with my contributions to Fidelity, and so I’m hoping that statement will show about the same results.

Though I’m certainly not getting rich here (or even keeping up with inflation), at least I’m not losing money. Given the situation, that’s pretty good.

Interesting what these guys have invested in. Hmmm…they’ve stashed a fair amount in cash: 45 grand in the money market, another ten grand in cash reserves. But we remain invested in American Express, Bank of America, Berkshire Hathaway, Caterpillar (need lots of tractors, presumably, in Iraq and Afghanistan)…ConocoPhillips, Exxon Mobil, Occidental Petroleum (they like oil)…General Electric (they like energy overall). And get this: they like junk food: McDonald’s, Yum Brands.

Awww…lookit this photo: junk food is good for young love! Doesn’t that warm the cockles of your capitalist heart?

They’ve dumped some stuff…Seagate gone. Actually, they’ve dumped a lot of stuff: this statement is signficantly shorter than it has been in the past. Fewer stocks, more mutual funds. And I’ve never seen them move so much into cash holdings.

Well, my shirt may be slightly frayed, but at least I still have a shirt. This is not the time that I would like to retire, perforce by layoff. However, if it happens, apparently I won’t starve.

Financial Advisor to Investor: Don’t panic!

Below, an exchange that started with an update from my financial advisor.

Beloved youngish partner of Financial Dudes, LLC, to Funny about Money:

To enhance our ability to remain patient with respect to our long-term investment strategy, we raised the cash level in your portfolio again, by trimming allocations to specific securities.

In addition, we initiated the process to upgrade the quality of our client’s money market holdings to a U.S. Treasury based money market to avoid the turmoil swirling around some money market funds. If you were not in a U.S. Treasury money fund, you will see some activity in your affected accounts in the next day or so.

There certainly has been a tremendous amount of news to digest lately, and we are navigating these markets with your long-term goals in mind. We have seen, and likely will continue to see, short-term volatility in the value of many investments that we hold.

If you have any questions or concerns, simply give us a call.

Funny to BYPoFD:

Thanks, John–

I have about ten or twelve grand in Vanguard’s Prime Money Market fund. VG is claiming it’s not invested in Lehman or related unhappy sites, & so I’m guessing it’s OK to leave the money there… Would you advise moving that money to a different fund? Or into a credit union money market, which just now earns a grand 1.88 percent?

best, –vh

BYPoFDto Funny:

We just moved it to be on the safe side and don’t think there will be any issues with the money market. We will move it back at some point. I wouldn’t really fret the Vanguard money market as they are normally on the conservative side and I don’t think there will be any issues.

Funny toBYPoFD:

Good. I’d pretty much reached the same conclusion.

Doesn’t appear to be much safety anywhere in the current storm, eh?

BYPoFD to Funny:

Not really. Even putting it under your mattress you run the risk of someone stealing it. Eventually we will work through all the problem companies and the ones that survive will be the big winners like in the early 90’s. This seems to be happening with BofA.

The long and the short of it:

Don’t dive out of your money market fund. Especially if it’s with Vanguard. Stay the course.

Scary times

Well, we all had quite the adventure yesterday. I woke up an hour ago—12:30 in the morning local time—wondering if I should move all my investments into the money market. Nothing like the dead of night to ramp up the panic factor.

In fact, though, I see that Vanguard lost all of $738.13 against many tens of thousands of dollars, and so I’m feeling a little saner.

Don’t have up-to-the-minute data on how the big IRA (a different fund) that Stern and Reimer manage is doing, but in past slumps Stern has worked the occasional small miracle. Checking the current holdings, I see he dumped Morgan Stanley and AIG a while back…and interestingly, we own Bank of America. How does that man know? He’s bought my son’s employer, so I guess he doesn’t expect that outfit to crash in flames soon. A fair amount of oil: Occidental, Exxon, and Conoco Phillips. And…hmmm…he’s moved a ton of money into cash reserves. Yipe!

At any rate, I guess I won’t be going broke soon. Later, maybe, but not today.

w00t! 18 grand materializes from the air!

Lordie! Here I’ve been thinking I’d lost about $23,000 in the stock market…. Comes a statement from GDU’s Fidelity retirement plan-the first I’ve seen in a year. It turns out the balance the Fidelity rep gave me over the phone a few weeks ago was wrong. He only gave me the amount in the 401(a) plan. The fund also includes a 403(b) plan, which contains $18,465 more than the amount he said I had.

That means I’ve “only” lost about $4,535 to the bear.

Wow! I’ve never been so pleased with a loss in my life.

3 Comments left on iWeb site:

Mrs. Accountability

That’s wonderful!! Funny how the situation could cause such a paradigm shift

Friday, July 18, 200809:35 AM


Wow, that is so cool!

I’m too chicken for stock market… I saved up a bit but I don’t like the idea of potentially losing money. I mean, I wouldn’t mind your kind of loss though

Friday, July 18, 200807:00 PM

Funny about Money

In fact, you lose money in the market and you gain it. Over time, you should make more than you lose, if you’ve diversified and invested carefully.

With mutual funds where you’re simply rolling all gains back into the fund by automatically purchasing new shares with gains or buying new shares each month with savings from your paycheck, when the market goes down you stand to earn MORE money, because you buy shares at deflated prices. As the market comes back up, your existing shares plus the shares you bought in the bargain basement make money.

This is most obvious in your 401(k) or 403(b), where you and your employer are plowing money into the funds every payday. It’s hair-raising to get a statement that shows the plan has lost more than you and your employer combined put into it over the quarter…until you realize the contributions are buying lots of shares at reduced prices. When the market comes back to normal, you feel mighty flush.